Ask TheStreet: Secondaries

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Are secondary offerings good or bad for stocks? Best Regards, J.P.

Gregg Greenberg: Strip away all the fancy ratios used to value stocks -- the price/earnings, price/sales, price/book, etc. -- and ultimately you will find the price of a stock is determined by good old supply and demand. If more people want to buy shares of a stock than sell them, then the price will rise. If more people want to sell than buy, then the price will fall.

Keeping those immutable economic laws firmly in mind, it stands to reason that by raising the supply of stock via a secondary offering, then the price should go down if demand remains unchanged. And on the flip side, if a secondary offering spurs additional demand, then the price should remain unchanged or rise.

Confused? Don't be. Here's a recent real world example using -- what else? -- everybody's favorite stock, Google ( GOOG).

Google went public in August 2004 at $85 per share. In the initial public offering, a total of 19.6 million Google shares were sold for $1.67 billion. At the time, demand outstripped supply, and the IPO finished above $100 on its first day of trading.

A year later, Google raised $4.2 billion through the sale of another 14.2 million shares, called a secondary offering. By this time, however, Google-mania was in full effect, and the highly anticipated secondary offering was priced at $295 a share.

Why did Google decide to add more shares to the market when the price was rising so well on its own?

In general, secondary offerings are made by companies looking to refinance, or raise capital, which is positive for a growing company. At the time, there was speculation that Google was building up a war chest to enter new markets. And since the price for its stock was high, Google's management realized it was a good time to sell more stock.

Any dollars raised from these kinds of offerings go directly to the company, through the investment bank that underwrites the offering. That means the company can shore up its finances by selling additional stock, and by increasing the amount of shares in public hands. It also reduces the volatility of the shares already being traded.

However, as investors line up for a piece of a secondary offering, they may be buying when the stock is at risk of becoming dangerously diluted. Dilution has negative connotations simply because the company's shares -- and earnings -- will be spread across more stakeholders. Or, in other words, with more shares available, it decreases each shareholder's level of ownership, and anything that decreases an investor's level of ownership also decreases the value of his holdings.

Despite the added supply, there was still enough demand for Google's shares to send the stock higher from its September secondary offering price. By the end of 2005, Google shares were trading well over $400.

Fast forward to two weeks ago, when Google struck again. In order to accommodate index funds that needed to buy shares of the company as it joined the S&P 500, Google sold 5.3 million shares at $389.75 each.

So will demand for Google shares be satisfied now that this latest heap of stock was dumped onto the market? The IPO couldn't satisfy the demand, which sent the price higher. Neither did the first follow-on offering. Maybe the third time will be the charm.

Then again, maybe not.

How does option expiration influence the price of the underlying stock? Thank you, T

According to's options guru, Steven Smith, option activity can indeed influence trading in the underlying stock, but the impact is very short-term. For example, if an order comes in to buy a big slug of put options (bets that the stock will go down), the market makers selling the options to facilitate the trade would need to hedge the puts they sold by selling stock. This would create some short-term selling pressure.

But the tail cannot wag the dog for too long, says Smith, so the impact is short-lived.

As far as using option activity as a predictor or indicator for impending price moves, it's very difficult, open to interpretation and not too reliable.

The main tool for using options as a contrary indicator is the put/call ratio. A high level of put volume tends to suggest bearish sentiment and might be interpreted, from a contrarian standpoint, as bullish.

The name of this indicator refers to the two main options classes, those that become valuable when the underlying stocks fall (puts) and rise (calls). The put-to-call ratio is simply the volume of all puts divided by the volume of all calls that trade on a particular day. Like the VIX, which measures the market's volatility, the put-to-call ratio runs in direct proportion to investors' nerves: The higher the number, the shakier their knees.

A reading over 1.0 indicates bearishness in the market, because a high level of put-buying indicates a rising level of fear. That, of course, is bullish if you're a contrarian betting against sentiment.

"Typically, traders like to see the put/call hit 1.5 or higher to get an oversold signal," says Smith. "But on a big down day, such as a market crash, it can hit extreme readings of 4 or greater. On the other hand, a reading of 0.50 or below indicates a high level of bullishness. So contrarians might think the market top is at hand and start selling."

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